What to Know about Investing with a Taxable Account

What to Know about Investing with a Taxable Account

Once you’ve maxed out your annual IRA contribution, you might want to look at other investment options for the rest of your savings. High earners may not be eligible for Roth IRA accounts, leaving you to look at standard investment accounts as an alternative. While these accounts are taxable, they can also provide a tax shelter when managed properly. Here are a few things to remember about taxable investing.

1. Capital Gains Tax is Less Than Income Tax

Income tax rates are typically much higher than capital gains taxes, so it makes sense to put as much of your investment earnings into eligible accounts as possible. Short-term investments, those you cash out in less than a year, are considered part of your income for that year. Longer term accounts accrue income as capital gains. Be prepared to leave your investments alone for at least a year to avoid the higher tax rate. Beginner investor? See our top rated investing sites as you get started.

2. Dividends Cost More than Growth

High dividend stock can offer a way to grow your investment even when the markets are particularly volatile. Unfortunately, dividends count as income, and you are required to pay the taxes on them annually, even when you immediately reinvest. So, leave high dividend stocks for your IRA accounts which can grow tax-free. Focus your taxable investments on high growth stocks which add value without adding to your tax burden.

3. Taxable Accounts Do Better with Passive Management

Actively managed funds may offer a slightly better return on your investment, but they also come with added expenses. Not only will you pay more in fees, you will also face more taxable events as stocks are sold and investments rebalanced based on changes to the market. That can leave you paying capital gains taxes several times per year, which can be costly when you aren’t trying to withdraw the funds. Some of the best robo advisors can help you implement tax loss harvesting, which offsets capital gains.

Taxable accounts offer more financial flexibility than retirement accounts that avoid taxes. There are no minimum distributions or required cash out policies. Instead, these are accounts that can stay invested until you need them. Given the greater flexibility of these accounts, they make a great option for someone with excess savings that is looking for a way to grow personal wealth. Just keep in mind some of the tax liabilities and be sure to discuss the implications with your tax advisor.

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